Market Commentary – 22nd March 2017
The Fed raises rates and Article 50 to be triggered next Wednesday!
It has been a week of two halves, with strength seen in equities following the Fed’s and Bank of England’s monetary policy meetings, however, equity markets did begin to pull back on Tuesday and have continued the trend this morning. Growing doubt regarding the ability of President Donald Trump to deliver on his campaign promises of cutting taxes and pro-growth policies have led global equity markets to sell off. Most economic data released over the last week has been centred around inflation and wage readings, with little other hard data such as production or GDP numbers. There has been lots of political news, including events surrounding the busy election calendar in Europe, the meeting of major political leaders and an official date being announced for triggering Article 50. Therefore, much of the movements in the markets have been driven by the actions and comments from the BoE and Fed, and the political news flow.
In Europe, Dutch Prime Minister Mark Rutte has praised voters for keeping him in office and keeping the nation away from the “wrong side of populism”. Wednesday’s general election in the Netherlands saw Rutte’s centre-right VVD easily beat Geert Wilders’s far-right, PVV party, which gained five seats. The first debate of the French presidential election saw Emmanuel Macron outperform Marine Le Pen, according to two snap polls. Against Le Pen’s attacks, Macron repeated that he sees a “strong France in Europe”. Macron is still seen as the most likely winner of the presidential election. He will, however, find it difficult to assemble a majority in parliament which would be needed to implement his reformist programme. Given the favourable result in last week’s Dutch election, and with Macron now tied with Le Pen in the first-round polls and comfortably ahead in the second-round polls, political uncertainty seems to be on the retreat in the Eurozone.
Following the Article 50 bill receiving royal ascent last week, Prime Minister Theresa May will trigger Article 50 next week and begin the Brexit process by notifying the European Union that the UK is leaving. Downing Street said she would write to the European Council on 29 March. Negotiations on the terms of Britain’s exit from the EU will then begin and the EU says it is “ready and waiting” for the letter.
Global Economic News
In the UK, the Monetary Policy Committee voted to leave the base rate unchanged last Thursday, however, this was not the view shared by all. There was a surprise vote in favour of a rate hike from Kristin Forbes and more hawkish noises from some of the other members. Her move has little relevance in terms of future policy moves, given that she will only vote in two more meetings before she leaves the MPC on 30 June. Markets focused on the suggestion that “some” members would switch their vote soon if growth and inflation continued to surprise on the upside. But there has been little in the public utterances of MPC members to suggest this is anything other than a fairly small group which would not command a majority if they switched en masse now, let alone once Ms Forbes has departed. With growth set to slow and wages likely to remain subdued, the chances of a 2017 rate hike remain low. CPI inflation continued to accelerate in February, rising from 1.8% to 2.3%, the highest rate in three-and-a-half years, while CPIH – the ONS’s new headline measure – also came in at 2.3%. February’s pickup – which was a little larger than expected – was mostly due to the unwinding of January’s unusual seasonal movements in clothing prices and a sizeable contribution from petrol, which had seen prices rise between January and February this year but fall over the same period in 2016. The effects of the weaker pound should continue to feed through as we move through the year, taking the CPI and CPIH measures close to – or possibly even above – 3% towards the end of 2017.
In Europe, data for Q4 revealed that annual growth in hourly labour cost in the Eurozone rose from 1.4% to 1.6%. As usual, the figures showed large divergences across countries. Germany, where the labour market is very tight, saw labour costs up by 3% in annual terms, whereas Spain’s rose just 0.1%. Although Q4’s data does not alter the underlying picture that nominal wage growth remains modest in the Eurozone as a whole, it confirms that an upward trend is in place and that domestically-generated price pressures are likely to start building gradually. Consumer prices in the Eurozone increased 2% year-on-year in February of 2017, up from 1.8% in January and in line with preliminary figures. It is the highest inflation rate since January of 2013, due to a rise in energy prices. Core inflation for February remained unchanged at 0.9% year on year.
Looking to the US, the Fed lifted the fed funds target range by 25 basis points from 0.75% to 1.00%. There were no large surprises in the policy statement, economic and interest rate projections, or in Chair Yellen’s press conference. The statement emphasized that there is symmetry surrounding the 2% inflation target – it
could go slightly above 2% for a brief period. Following the moderate upward move in the median dot plot estimates in December, the median estimates for the fed funds rate were not changed for 2017 or 2018, and moved just slightly higher in 2019 to 3% from 2.88% in December. The consensus for three rate hikes in each of 2017 and 2018 strengthened as the number of policy makers looking for three rate hikes in 2017 increased to 9 from 6 and in 2018 the number of officials rose to 6 from 3. Looking to inflation, February CPI was up 0.1% and Core CPI rose 0.2%, both as expected. Headline CPI was up 2.7% from a year ago, while core inflation rose 2.2% year-on-year. The trend in CPI inflation signals that PCE inflation is on a trajectory to reach the Fed’s 2% target.
US Earnings – As of 17th March, (with 4 companies in the S&P 500 reporting actual results for Q1 2017), 2 S&P 500 companies have beat the mean EPS estimate and 2 S&P 500 companies have beat the mean sales estimate. Earnings Growth: For Q1 2017, the estimated earnings growth rate for the S&P 500 is 9.0%. If 9.0% is the actual growth rate for the quarter, it will mark the highest (year-over-year) earnings growth for the index since Q4 2011 (11.6%).
UK & Non-UK Gilt Yields; Over the last week we have seen bond yields moving upwards and correspondingly valuations falling. This was the common theme across the UK, Europe and the US. US treasury yields fell back following the Fed’s rate decision, as markets had priced in the possibility of 4 rate rises for 2017 and a more hawkish tone from the Fed. With further US rate rises expected and inflation slowly rising in Europe, we still expect to see yields rising, accepting that political uncertainty can see a flight to the ‘perceived’ safety of bonds, which would be positive for valuations. Volatility remains high in these assets that should not be functioning like this, which is a further example of why we are still not directionally investing into these assets.
GBP to USD/Euro/JPY;
Sterling is up against the dollar over the last week, and is testing the upper end our expectation range. Whilst some of this strength was attributed to the uptick in UK inflation and some hawkish comments from members of the MPC, the overarching story was a weaker dollar. The dollar fell against most major currencies following the Fed’s comments and decision to raise the fed funds range by 25 bps. Whilst this seems counterintuitive, as a rate rise is positive for the domestic currency, the dollar weakness was down to expectations of the fed’s dot plot scenario, regarding the pace of rate rises. The market was pricing the chance of four rate rises in 2017, whilst the Fed’s guidance was virtually unchanged and the absence of more hawkish comments lead the dollar to sell off. Sterling was broadly flat against the euro. The euro has seen some reasonable strength against the dollar, but this has not lead to much change with the euro / sterling pair. We will continue to keep a close eye as the UK approaches triggering Article 50. Weaker sterling is positive for our overseas assets, whereas strengthening of sterling is negative for our overseas assets. We still see downside risks to sterling as we move to negotiating Brexit and for that reason we continue to prefer holding unhedged positions.
- GBP / USD – Range 1.25 – 1.10 – Today 1.24
- GBP / EUR – Range 1.20 – 1.10 – Today 1.15
- GBP / JPY – Range 150 – 125 – Today 138.7
Oil is lower over the week and is trading at $47.55 for WTI Crude and $50.21 for Brent, down 2.3% for WTI and around 3% for Brent. Record crude stockpiles and rebounding production in the U.S. suggest that the curbs by OPEC and Russia aren’t working fast enough. U.S. shale oil producers have been adding rigs, pushing up the country’s oil production to about 9.1 million bpd, from around 8.5 million bpd in late 2016. The increasing supply story, along with stable global demand has weakened the recent price stability that has been present in the oil market. Following the drop in prices over the last week, oil is very close to falling outside our expected range of $50-60 / barrel and there does appear to be a more bearish case in the short term, however, the next OPEC meeting on 25 May will certainly draw attention and give some guidance on where production and inventories might be as we progress through the year.
Gold is up by $45 / troy ounce this week and is currently trading at $1,245 / troy ounce. The increasing gold price has been down to a few factors. Following the Fed’s decision to raise rates, gold rallied, as the Fed’s dot plot guidance was virtually unchanged whilst the market had begun to price the chance of faster rate rises, with four rises being considered for 2017. Holding gold becomes more attractive when the pace of rate rises is perceived to be slower, as gold is a non-yielding asset. Additionally, the weakening dollar made gold, which is priced in dollars, more attractive to international investors. As equities sold off yesterday and into today, gold reacted as expected and bid up. It is reassuring to see gold functioning as expected when risk sells off in the market, however, we do not anticipate this to mark the start of a risk off period, more equities paring back following extended rallies over the last few months. We do not expect much upside potential for gold in the current environment, and although it is a good diversifier, unless we see risks of a soft Brexit decrease and sterling falling substantially, there is no gain to be made accepting it is a safe asset.
Model Portfolios & Indices
Over the last week, we have seen most market indices that we track move higher. Note that the data runs to the close of 20th March, therefore yesterday’s market movements are not reflected and will feed through in next week’s performance data.
In the US, the three major indices were up for the week to 20th March, however, it was the UK and Europe that stood out. The FTSE 100 and 250 hit new records during the week, but have dropped back from the levels seen at the beginning of the week. There were also positive moves in the major Eurozone countries. The Hang Seng in Hong Kong continued advancing and was the strongest performing index of those we track.
Despite the strong performance in equities, the stronger dollar has dragged on the portfolios. Overall, the portfolios were marginally down over the week. OBI 5 bucked the trend and was marginally up. The portfolios lagged the benchmarks this week, however, if you look at the one month performance the portfolios were above their benchmark, bar OBI 5 which we have highlighted is more defensive than the benchmark.
Within the portfolios, we still have positions exceeding their expected 6 month return target after only 12 weeks and this has triggered a subcommittee meeting, where we reviewed the economic data and determined whether we are at a point where risks have increased or the whole data set has moved up.
We have decided to not take any profits on these positions as the economic data we are looking at has improved since we set the forward guidance in January. We feel that the range has moved up, so the value at risk on the positions has not become higher than we originally set in January. We feel the negative value at risk we set in January is still the same despite the growth in asset values since. We are therefore comfortable for now that the risks in the portfolios are as balanced now as they were at the beginning of January, despite the positive momentum in the intervening period.
We will review these positions in full continually between now and the next full investment committee meeting and monitor the economic data to ensure this position remains unchanged. We will continue to monitor and evaluate and watch the economic data.
This day in History
On this day in 1993, the Intel Corporation produces the first Pentium microprocessor. Intel holds around 80% of the world’s market share in the PC microprocessor business.
As always have a great week and we will continue to watch and evaluate and if anything changes we will let you know.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager